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Capital Taxation with Heterogeneous Discounting and Collateralized Borrowing

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We study optimal long-run capital taxation in a closed economy with heterogeneity in agents' time-discount factors where borrowing is allowed but restricted by a collateral constraint. Financial frictions distort intertemporal optimization margins and the tax system serves a dual role: first, it is used to finance government consumption; second, it serves to alleviate the distortions arising from the binding collateral constraint. The discrepancy between the private and the social discount factors pushes for a subsidy on capital, while the discrepancy introduced by the collateral constraint pushes for a tax in the long-run. When consumption smoothing motives are muted, the two effects counter-balance each other and the tax is zero. With finite elasticity of intertemporal substitution, the second discrepancy dominates and the tax on capital income is positive in the long-run.

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  • Nina Biljanovska & Alexandros Vardoulakis, 2017. "Capital Taxation with Heterogeneous Discounting and Collateralized Borrowing," Finance and Economics Discussion Series 2017-053, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2017-53
    DOI: 10.17016/FEDS.2017.053
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    More about this item

    Keywords

    Ramsey taxation; Collateral constraint; Heterogeneous discount factors; Tax on capital;
    All these keywords.

    JEL classification:

    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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